What's the Difference Between Rate and APY?
Friday, 10 May 2019
If you've ever shopped for a money market account, you probably noticed some accounts are advertised with two rate numbers. Ever wonder why?
Well, you're not alone. Ads with multiple rate-related numbers for the same account can certainly be confusing. But there is an important difference between the numbers and an equally important reason why both are listed. Here's what these numbers mean and why they're important:
First, there's the interest rate.
Often times when a money market account is advertised with two numbers, the first number is a special introductory interest rate.
Let's say the account is advertised with an introductory rate of 5% for six months. This means when you open your account, you will earn 5% interest on your balance for the first six months. Pretty straightforward.
But what happens after six months? What will you earn then? That's when the second number, the APY, comes in.
Then, there's the APY (Annual Percentage Yield).
After six months, the rate on your account will change, or adjust. And since introductory rates are promotional, they are often higher than the non-promotional rate the bank is currently paying on money market accounts. Which means the rate you will earn in the second six months will likely be lower than 5%.
For this example, let's say the current, non-promotional rate the bank is paying on money market accounts is 3%. Therefore, you would earn 5% for six months and then you would earn 3% for the next six months.
The APY, or annual percentage yield, is the rate you would earn during the one-year period factoring in the two different rates — 5% and 3%. Therefore, the APY will be lower than 5%, and also a more accurate description of how much you will earn in one year.
Here's another way of looking at this:
What if the introductory rate was for one year? Then you would earn 5% for the entire first year. In this example, the interest rate would be 5% and the APY would be 5% as well. There are no rate adjustments — or different rates — to factor in so the rate and APY are the same.
Comparing apples to apples.
As you can see, it's important to understand what the two numbers are and how they affect your earnings. Understanding the difference is also helpful when comparing money market accounts, as the APY is a more accurate description of how much you will earn on an account.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial advisor about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates.
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